Model of errors and irregularities as a general framework for risk-based audit planning;

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A Model of Errors and Irregularities as a General Framework for Risk-Based Audit Planning
Jere R.Francis
University of Missouri Richard A. Grimlund
University of Iowa
INTRODUCTION
Auditing standards define the objective of an audit as providing assurance that financial statements are presented fairly in accordance with generally accepted accounting principles (GAAP). Exactly how this should be achieved has been a subject of much interest in recent years. Now, because of SAS 58, the term "presented fairly" requires that the auditor must obtain reasonable assurance that the financial statements are free of material misstatements. This is in addition to the historical role of gathering positive evidence to support the assertion that the financial statements conform to GAAP, as applied on a consistent basis.1
SAS 53, issued at the same time as SAS 58, provides some guidance with respect to the auditor's evaluation of whether the financial statements are free of material misstatements (hereafter called errors and irregularities). For example SAS 53, paragraph 6, states:
The auditor should assess the risks that errors and irregularities may cause financial statements to contain material misstatements. Based on that assessment, the auditor should design the audit to provide reasonable assurance of detecting errors and irregularities that are material to the financial statements. The auditor's assessment of the material misstatement of financial statements requires the auditor to understand the characteristics of errors and irregularities... Based on that understanding, the auditor develops and performs appropriate audit procedures and evaluates the results.
Of particular importance are the last two sentences which require the auditor to understand the "characteristics" of errors and irregularities, and based on that "understanding" to develop appropriate audit procedures.
In line with SAS 53, the purpose of our paper is facilitate the auditor's understanding of the characteristics of errors and irregularities. This is a necessary first step to fully implement the kind of risk-based auditing articulated in SASs 53 and 58. We do this by developing a model of financial statement errors and irregularities that can be used to assist in the process of risk-based audit planning.2 The objective of the model, to echo SAS 53, is to better understand the "characteristics of errors and irregularities" with a goal of planning "appropriate audit procedures" in order for the auditor to have "reasonable assurance of detecting errors and irregularities."
1 The scope paragraph of the standard audit report as required by SAS 58 makes this responsibility explicit.
2 We do not claim that ours is the only analysis of errors and irregularities. For example Mautz and Sharaf (1961, Chapter 6) evaluate sources of financial statement misstatements and how the auditor may detect them.
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